Goldman Sachs's Underwriting Assailed by Judge

William K. Black has described what happens when banks are deregulated, de-supervised and decriminalized in an article posted on the New Economic Perspectives blog called "The High Price of the President's Council of Economic Advisors' Failure to Read Akerlof & Romer." In that article, he describes the dangers of accounting control fraud in banks which can be evident in their underwriting practices as follows:

...A well run banking system does reduce adverse selection and make markets less inefficient. A well run banking system does so by engaging in expert underwriting of significant loans such as home loans. A bank that does not engage in expert underwriting poses a grave danger. At best, it is incompetent. Far more dangerously, it is often engaged in accounting control fraud. A regulation that requires a lender to engage in prudent underwriting imposes no costs on honest banks and it saves society from vast amounts of damage. When the regulatory agencies gutted the underwriting rules by turning them into guidelines they set us on the road to the Great Recession. Effective financial regulation begins with mandating prudent underwriting. Rules mandating prudent underwriting make financial markets far more efficient and stable by blocking the perverse Gresham’s dynamic that otherwise can create a criminogenic environment.

Maybe there is progress being made in bringing investment banks like Goldman Sachs to justice where the underwriting can't be justified because of "faulty data from appraisers or expired statutes of limitation" in order to avoid a suit. The Federal Home Loan Bank of Seattle has filed a case against Goldman Sachs accusing them of making false representations in a loan pool it bought in 2007 for $105 million.

Moody's and Standard and Poors did the credit ratings which were later downgraded to junk.

According to the Judge, Underwriters are "liable for materially untrue or misleading statements."

BofA, Goldman Sachs Find State Mortgage-Securities Cases hard to Shake
By Karen Gullo - Bloomberg

. . . .

‘Nice Suit’

“The burden of proof is less in the state cases,” said William Black, law and economics professor at University of Missouri and former litigation director at the Federal Home Loan Bank Board, explaining why investors favor the venue over federal courts.

Black said state court plaintiffs stand a better chance of getting a judge who isn’t “hostile to the notion that someone in a nice suit made a false representation selling securities.”

. . . .

Credit Quality

In securitizations, a large number of loans are grouped into a pool and sold to a trust which raises money for the purchase by selling bonds, or certificates.

The underwriters purchase certificates from the trust and sell them to investors. They gather statistics and data about the loans’ credit quality to include in documents filed with regulators when the securities are offered for sale.

The cash flow from the loans in the pool is the source of funds to pay the holders of the certificates. Loans backing these certificates that went into default were a key part of the financial crisis in 2008 that helped send the U.S. into the biggest recession since the 1930s.

In more than a dozen cases filed in state courts since 2009, investors have alleged that the offering documents prepared by the underwriters contained false or misleading information about the loans, such as how much equity borrowers had in their homes, the appraised value of the home and the criteria used by lenders to decide whether borrowers should get loans.

Countrywide, IndyMac

The loans were originated or acquired by Countrywide Financial Corp., IndyMac Bank, GreenPoint Mortgage Funding Inc., National City Mortgage and others, according to the complaints.

Countrywide, based in Calabasas, California, was once the biggest U.S. residential home lender, originating or purchasing about $1.4 trillion in mortgages from 2005 to 2007. The bulk of them were sold to investors as mortgage-backed securities. Bank of America acquired Countrywide in 2008.

The lawsuits are separate from group, or class-action, cases pending in federal courts where some institutional investors may have to settle for less than 1 percent of what they initially sought because judges have scaled back or dismissed claims.

The state cases also aren’t covered by an $8.5 billion settlement announced June 29 between Bank of America and 22 institutional investors in Countrywide mortgage-backed securities. That accord, if approved, will resolve investors’ claims that Countrywide was required under contract to repurchase loans that didn’t meet its underwriting guidelines.

Credit Ratings

The Federal Home Loan Bank of Seattle, in one of 11 lawsuits it filed in Washington’s King County Superior Court against underwriters, claimed that New York-based Goldman Sachs’s offering documents made false representations about more than half of the loans in a 2,793-loan pool that it bought in 2007 for $105 million.

The security, originally given the highest credit ratings by Moody’s Investors Service and Standard & Poor’s, has been downgraded to junk status, according to the complaint.

Goldman Sachs claimed that the lawsuit should be dismissed because it can’t be sued over statements in the offering documents that came from other parties.

Washington’s investor protection law holds underwriters strictly liable for materially untrue or misleading statements, “regardless of the ultimate source of those statements,” Judge Laura Inveen said in a July 19 order.

. . . .

Read the entire article here